Question

Q3: Talia is deciding whether to operate her own consulting business or to continue working as a marketing assistant for another employer, where she earns $45,000 a year. If she operates her own business, she expects to spend $70,000 in rent, $50,000 for assistants, and $24,000 on her own salary (all annual figures). Also, she will have to use her savings of $60,000, which is earning interest of 2% per year in a savings account and borrow $80,000 at an interest rate of 7% per year to purchase $140,000 worth of computer equipment and furniture that will depreciate by $17,500 per year. Talia expects the business to generate total revenues of $200,000 per year after it has been operating for several years and has matured. Finally, businesses that are equally risky as her intended consulting business are generating a return of 18% per year for investors.

a) What are the expected annual implicit costs of Talia’s intended consulting business AND what do they add up to?

Hint: there are only two implicit costs.

b) What are the expected annual explicit costs of Talia’s intended consulting business AND what do they add up to?

c) What is the expected annual economic profit of Talia’s intended consulting business?

d) What is the expected annual accounting profit of Talia’s intended consulting business?

e) What amount of income would Talia earn if she operated her consulting business?

Hint: Follow the actual money that flows to Talia.

f) What amount of income would Talia earn if she chose the best alternative to operating her own consulting business?

g) Would an economist recommend that Talia’s start her own consulting business? Explain.

Q4: Janice operates her own business and pays herself a salary from her business. The implicit cost of Janice’s time and effort in operating her business is equal to $0. How is this possible? Explain.

Answer 1

a) Implicit costs = Opportunity costs = Interest forgone on 60000 + Salary forgone of 45000 - Salary of 24000

= 2%*60000+45000 - 24000

= 22200

b) Explicit costs = Rent + Assistants + Salary + Interest costs + Depreciation

= 70000+50000+24000+7%*80000+17500

= 167100

c) Economic Profit = Revenue - Explicit costs - implicit costs

= 200000-167100-22200

=10700

d) Accounting Profit = Revenue - Explicit costs

= 200000-167100

=32900

e) Talia earns = Salary + Accountin Profit

=24000+32900

=56900

f) Total investment * 18% = 140000*18% = 25200

OR

If she continues in old job = Salary + 2%*60000 = 46200

g) Yes, Talia should start her own consulting firm. As her earnings are greater than best alternative.

Q4)

Yes, implicit cost can be zero, if she pays herself salary equal to salary forgone from previous job plus interest forgone on her contribution to this business.